AP Macro Test Flashcards
Why do we only include ‘final’ goods and services?
To prevent double counting
What is GDP and how is it calculated?
The total value of all final goods and services produced in a year within a country
Are financial transactions included in GDP?
No.
Why is GDP an imperfect measure of societal well-being?
It ignores income distribution and doesn’t factor out spending on disaster relief and epidemic costs
What is national income?
The sum of income earned by the factors of production owned by the citizens. Includes wages from labor, rent for land, and interest for money
Expenditure approach for calculating GDP
GDP = C + I + G + (X - M)
Personal income
Income received by households before personal taxes
Perform the income approach for calculating GDP.
National Income + Depreciation - Subsidy Payments + Net Income of Foreigners
Why is depreciation added to national income?
Depreciation expenses are subtracted from corporate profits before NI calculation, so they need to be re-added to reflect the value of the output needed to replace or repair worn out capital.
How is “net income of foreigners” calculated?
Income of foreigners working here - Income of native citizens working abroad
Why must we add the net income of foreign workers to NI?
NI includes the income of all citizens everywhere. Therefore, to calculate GDP, which includes the value of all goods produced domestically, we need to subtract the production of goods by domestic people that is made abroad.
GDP includes the value of goods produced _______ by _______
domestically, anyone
Money Illusion
When nominal salary goes up (but not real salary), which tricks consumers into excessive spending
How are menu costs a consequence of inflation?
Higher prices force businesses to print/publish new prices
Those who borrowed money at fixed rates pay back amounts that are worth _______ in real terms due to inflation
less
How is CPI calculated?
(cost of base year market basket at current prices / Cost of base year market basket at base year prices) x 100
Calculate inflation between years
[(CPI in year z/CPI in year Y)-1] * 100
The PPI is useful for ______
predicting future inflation, since companies pass costs onto the consumers
GDP Product Deflater is the same as the PPI, except it uses the __________
current year market basket
Frictional unemployment
People who are between jobs
Structural unemployment
A mismatch of skills, or people that are unemployed by the structure of laws and policies
Labor force participationo rate
Number of people in the labor force divided by the working age population
Cyclical unemployment
Results from downturns in the business cycle
Seasonal unemployment
Results from the time of year
Dishonest workers
Claim to be unemployed to get unemployment benefits
Discouraged workers
Willing and able to work, but become so frustrated in the job search that they stop trying. They might be a reason that the unemployment rate is understated
Natural rate of unemployment in the US
about 5%
Which part of the AS curve is Keynesian, which one is intermediate, and which one is classical?
Classical on top (stays at physical limit), intermediate in the middle (duh), Keynesian or Depression stage (no change in price level)
Why is the LRAS a straight line?
The fact that wages, salaries, and input prices will adjust eventually to the price of the final good. (Price of final good goes up, price of factors of production will go up too as demand for them go up.) Therefore, price is not really a determining factor for output.
LRAS is at the level that corresponds with __________
full employment
Say’s Law
Supply creates its own demand
3 reasons why AD has a negative slope:
Real Wealth Effect, Foreign Trade Effect, Interest Rate Effect
The Real Wealth Effect
When price level increases, value of assets such as cash and checking-account balances fall. Therefore, real purchasing power falls and people will buy less at higher price levels.
Foreign trade effect
When price level in one country increases, prices of imports become less expensive and exports from that country become more expensive. Therefore, more imported goods and less exports.
The interest rate effect
When price level increases, the real quantity of money decreases. Therefore, people need more loans to continue current consumption levels, which increases demand for money and decreases supply of loanable funds. Therefore, interest rate must increase, which leads to a decrease in RGDP as households and firms put off major purchases.
Stagflation
Combination of rising prices and falling output (decreases in AS)
Demand-pull inflation
When AD curve shifts out to the right causing inflation
Cost-push inflation
When AS pushes to the left and causes inflation
Creeping inflation
Low inflation rates for a long period
Galloping inflation
Inflation > 10% per year and grows month after month
Hyperinflation
Price increases > 50% per year
Recessionary gap
When the equilibrium GDP level is below full employment
Inflationary gap
When equilibrium RGDP is greater than full employment RGDP
Full capacity
Every resource is being used. 0% unemployment.
Law of One Price
States that every good should have the same price in different countries due to continued arbitrage
Purchasing Power Parity
One currency will have the same purchasing power when converted to another currency
Since not all goods can be transported from one location to another, neither the _________ or ________ always holds
purchasing power parity, law of one price
Why does supply drift towards full employment?
When there is a lot of unemployment, it is cheaper for firms to hire workers than it is when there is full employment.
Average growth of RGDP in the US per year
3%
How do we get the equation I = S + (T-G)
Financial intermediaries only have 1 outflow and 2 inflows.
I = S + (T-G)
Explain the effects in order of expansionary fiscal policy on an open economy.
Government spending increases/taxes decrease -> Higher interest rates as government needs to borrow more -> Interest demand for domestic currency increases -> Appreciation of domestic currency -> Exports decrease and imports increase -> Net exports decrease
Explain the effects of contractionary fiscal policy on an open economy.
Government spending decreases/ taxes increase -> Lower interest rates (government demands less) -> Decreased demand for domestic currency for investment purposes -> depreciation of the domestic currency -> exports increase and imports decrease -> Net exports increase, partially offsetting contractionary policy
Crowding out
When the government crowds out private investment when it requires more money to perform expansionary fiscal policy
Primary functions of money
Medium of exchange, store of value, and unit of account
Medium of exchange
Provides a common platform for people to exchange things (prevents barter)
Double coincidence of wants
When the person you want to barter with likes something that you have by chance
Fiat money
Money that has no intrinsic money
Commodity money
Has value and is based on something that has real value
Store of Value
Money doesn’t erode and keeps value well, as opposed to a cow, which will die.
Unit of account
Money provides a standard unit for price listings so you can easily compare
M1
Sum of coin and paper money plus checking deposits and traveler’s checks
M2
M1 + Savings deposits, small time deposits, money market mutual funds, Eurodollar deposits
Money multiplier =
1 / required reserve ratio
Tools of the Fed to control money supply
Adjustments in required reserve ratio, adjustments in discount rate paid by banks to borrow from the Fed, and OMOs
List all the ways Fed can do contractionary monetary policy.
Increase required reserve ratio, increase discount rate, sell bonds
List all types of expansionary monetary policy the Fed could do
Sell bonds, decrease RRR, decrease discount rate
When investment in capital resources goes down in the current period, future output is ____________
sacrificed because there is less capital for use in production
Liquidity Trap
When money demand curve is flat and movements in money supply do not impact interest rates at all
Keynesians also believe that the investment demand curve is _______, making it unresponsive to changes in the interest rate
inelastic
Keynesians favor ______ policy
fiscal
Equation of exchange
MV = PQ (M is money supply, V is velocity of money, P is average price, Q is quantity of goods and services sold in a period)
Velocity of money
The number of times per year that the average dollar is spent on final goods and services
Monetarists believe that the economy is inherently _____ and favor a _______
stable, steady increase in money supply proportional to the increase in RGDP
Natural rate of real interest is supported by _______
monetarists
Explain the Fisher effect.
If people are able to predict a tightening of the money supply that is intended to increase interest rates (thereby making consumption fall), they will stop investment immediately and interest rates might actually fall.
Money neutrality
When changes to the money supply do not result in changes in real variables in the long run
Explain the Fisher effect and why it works.
1.) Money neutrality - changes in the money supply in the long run do not change real variables. 2.) When the Fed enacts monetary policy, it results in new expected rates of inflation. (contractionary monetary policy is supposed to result in less inflation) 3.) These changes in the expected interest rate causes drops in the nominal interest rate (change in expected interest rate = change in interest rate). 4.) There is no effect on anything.
Budget deficit
G-T in one year
National debt
Accumulation of past deficits
Ricardian Equivalence theory
Deficit financing is no different from tax financing because if former is chosen. This is because when the government borrows (i.e., issues a bond), it will eventually have to pay that bond off at an interest rate.
A Phillips curve has ____ on the y-axis and ___ on the x-axis
Inflation rate (percent), unemployment rate (percent)
Movements in ____ move along the Phillips curve
AD
Supply shocks result in _______ movements of the whole Phillips curve
rightward (means more unemployment at every rate of inflation)
Merchandise trade balance
Exported goods - imported goods
Current account
trade balance + services balances + income on assets from abroad - payments on assets to people abroad
Capital account
Foreign purchases of home assets (stock, financial assets, or physical capital) - domestic purchases of foreign assets
Balance of payments always equals __
0
Quantity theory of money
Velocity of money is stable and so is Quantity of goods and services. Therefore, when M increases, only P will increase as well. Therefore, monetary policy has no effect other than price level increases.
